Debating "The Great Rotation": Will it Lift Trading Volumes?

A shift from fixed income into equities is unlikely to lift trading volumes and brokerage commissions up to previous highs, according to a Greenwich Associates report.

Many Wall Street professionals are waiting for “The Great Rotation” of assets out of fixed income, as the catalyst to restore U.S. institutional trading volumes in equities to their pre-financial crisis levels.

Three weeks ago Fed Chairman Ben Bernanke suggested that the central bank might slow its QE3 stimulus program “in a few weeks.” Since then the Street and economists have been parsing his words, and traders have been wagering when the stimulus might end. This has led to intense speculation and volatility in the U.S. equity markets.

Last Thursday, I attended a Liquidnet media briefing on “The Great Rotation” in which panelists discussed whether the Federal Reserve had begun the “tapering off” of its stimulus program. Most of the economists said the Great Rotation hasn’t happened and won’t happen for at least six months, and that the Fed wouldn’t do anything to disrupt the stability of the U.S. economy. With a weak U.S. recovery, high unemployment rate, and a drop in emerging market export outflows, “The Great Rotation is a macro story,” said Bruce Kasman, Chief Economist & Managing Director of Global Research, JP Morgan.

However, according to a new report by Greenwich Associates,” entitled “Five Reasons Why the Great Rotation Might Not Be So Great,” the long-awaited “Great Rotation” following an uptick in interest rates will not reverse the long-term slide of institutional trading volume in U.S. equities.

Eighty one percent of the buy-side institutions in the Greenwich study think U.S. equity market turnover will fail to rebound to pre-crisis levels by 2014. Daily trading volume in U.S. equities at about 6.3 billion shares is down by a third from the 2009 market high of roughly 9.3 billion.

Oddly, the slump in trading activity has occurred during historically strong market activity, noted Greenwich in its report summary. Also, institutional commission payments from institutions are in sync with market volatility, and go in the opposite direction during periods of rising market valuations.

“Given these patterns it’s possible that even with a strong rally sparked by an influx of assets from investors fleeing fixed income, trading activity could be dampened by a continuation of the low volatility and volume that has characterized the recent run-up,” wrote Greenwich Associates analyst Kevin Kozlowski.

Brokers Plan for New Normal

Equity brokers suffering from the prolonged slump in trading activity had been counting on an increase in interest rates to jumpstart trading. But according to Greenwich, brokers have begun planning for a new market normal in which trading volumes, commission payments and brokerage revenues remain at depressed levels. Brokers are now scaling back their business structures to align with a U.S. equity market of about $9 billion-$10 billion in annual institutional commissions, as opposed to the $13.9 billion peak reached in 2009. In taking steps to right size their business, Greenwich said that brokers are resorting to head count reductions, desk consolidation and cuts in compensation.

But there has been a lot of money flowing out of fixed income into equity mutual funds. According to one panelist at the Liquidnet Great Rotation breakfast, in the first week in June, $10 billion flowed out of fixed income. But that same, domestic equity funds had estimated outflows of $2.52 billion, while estimated inflows to world equity funds were $1.58 billion, according to Investment Company Institute (ICI) data.

“It’s not quite the great rotation but the beginnings of movement out,” said Zane Brown, fixed income strategist at Lord Abbett. Another expert, Rich Repetto, Principal, Equity Research, Sandler O’Neill & Partners, asked why hasn’t this Great Rotation occurred, noting that the S&P 500 was up 13 percent year to date. Repetto said he expects the Great Rotation to happen but a number of factors might impact it. First, retail trading as a gauge of investor sentiment is up 10 percent for Q2 at Schwab, E*Trade and TD Ameritrade. “It could be the best quarter since 2009,” said Repetto last Thursday. Another sign that the great rotation hasn’t come is the bifurcation between retail investors and advisers, said Repetto. Advisers moved out of cash relative to retail assets last year to catch the returns.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio